While it may not come as a shock like it did when Andhra Bank was forced to reverse its decision not to exercise the call option in December 2019, it could cause repercussions among investors looking for higher coupons on future bond sales.
“Investors expect issuers to exercise call options mostly after five years,” said Ajay Manglunia, managing director and head of fixed income at JM Financial. “National Insurance surprised the market, stoking fears of future similar bond sales. This will likely reduce investor appetite, leading to higher demand for yield in the primary market.
Already on Thursday, Yes Bank’s Tier II bonds changed hands yielding as high as 14.09% in the secondary market, about 300-400 basis points higher than previous trades. These bonds, rated BBB-, will mature in March 2026.
One basis point is 0.01 percentage point.
The call option is nothing but a built-in exit route, mostly after five years since a bond was issued.
“With regard to the repayment of subordinated debt in the amount of Rs 895 crore, please note that the company has decided not to exercise the call option due on Friday, March 25, 2022,” National Insurance said in a stock market notification on Wednesday.
Holders of non-convertible debentures will continue to hold the debentures until their maturity date of March 27, 2027, he said.
The bonds were sold on March 27, 2017, carrying a coupon of 8.35%.
The National Insurance Company instrument was then rated AAA, the highest rating. Over a period, the public insurer suffered downgrades. It is now rated A+ with stable outlook by ICRA Ratings and AA with negative outlook by Crisil.
“Such an event will certainly dampen the sentiments of subordinated debt instruments, and it will further affect low-rated credit-grade bonds in general and in the insurance sector in particular,” said Venkatakrishnan Srinivasan, founder of Rockfort Fincap. “Similar rated issuers may need to offer higher yields to raise funds in the local market,” he said.
National Insurance bonds were traded half a dozen times in the secondary market between February 3 and February 15 this year, yielding a range of 7.95-8.22%.
“Some investors may have been rushing out of positions in the general insurance company,” said a bond broker, who traded the bonds, now mostly held by pension fund managers.
Interestingly, three trades in the second half of January yielded an upper range of 10.97-11%, according to data compiled by JM Financial.
A number of insurers including HDFC Life, ICICI Prudential Life, Star Health and Allied Insurance, Max Life, Niva Bupa Health, Start Union Dai-chi, Aditya Birla Sun Life, PNB MetLife India, HDFC ERGO General and Royal Sundaram Insurance have thus far tapped the bond market with an outstanding amount of around Rs 4,046 crore.
“If National Insurance had exercised the call option, it would have been hard pressed to raise new bonds unless it offered a high single-digit coupon,” said a senior executive at a bond house.
It is not mandatory to exercise the purchase option. However, financial markets have their own set of unspoken rules. Sometimes an agreement is made between borrowers and investors when the bonds are sold. These factors also affect the price of these debt securities.